Even the Australian Property Bulls Are Worried

It is well known that China’s credit boom created Australia’s iron ore/coal boom, which created the terms of trade boom, mining boom and the national income boom.

This in turn maintained high rates of employment (incomes) which promoted leveraged investment into Australia’s favourite investment class, property.

So it’s not too much of a stretch to see that China gave property another (last?) leg up in a bull market that’s stretched nearly 25 years. Throw in supply side issues from poor government planning, high building costs etc, etc, and you have a property price bubble that you could argue is built on fundamentals.

The fundamentals in this case being strong and rising national incomes, lack of new housing supply, cheap credit and the high cost of labour/supplies/regulations. But that’s the point…bubbles are always built on strong fundamentals. The problem is that this argument then becomes so blithely accepted that most don’t see when fundamentals stop being supportive of further growth.

We bring this point up for a couple of reasons. Early this week we sent this story around the office. It’s about a nondescript suburban home in the Sydney suburb of Eastwood that sold for $2.385 million.

Now, anyone who knows the suburb of Eastwood knows that’s a pretty outrageous price. Eastwood is middle class suburbia. It’s not the ‘north shore’ and not western Sydney. But over $2 mil for a regular house? Really? Oh, apparently the block was big.

So that’s a pretty decent anecdote about the level of craziness going on in Sydney’s housing markets. Historically low interest rates may not necessarily stimulate economic growth just where it’s wanted, but they do unleash a frenzy of speculative interest in an asset class where it’s deemed impossible to lose.

And then there was housing bull Chris Joye’s article in the Financial Review, where he stated that he was very worried about the state of the housing market. Joye’s been a pretty vocal bull for many years but now he’s concerned about the level of speculation that low interest rates are bringing about.

And he should know. He is a director of Yellow Brick Road Funds Management, which among other things is a fledging mortgage provider. Perhaps the quality of the applicants for new loans is beginning to cause alarm?

Anyway, here are a few quotes from Joye’s article. The worrying message that they contain won’t really be news to long time readers, but it does show the sort of thinking that is starting to slip into the mainstream’s consciousness.

‘households have not really deleveraged despite much spruiking about our "cautious consumers”. Australia’s elevated household debt-to-income ratio, which looks set to climb further, is not far off the all-time, pre-GFC peak.

‘This highly leveraged consumer is an artefact of Australia’s even more leveraged banking system. The major banks are leveraged about 80 times across their $1 trillion home loan books. Put differently, they are only holding about $1.25 of true loss-absorbing capital against every $100 – as opposed to the "risk-weighted” value – of their assets.’

And

‘…the banking system is under tremendous pressure to maintain its internationally lofty returns on equity.

‘Although default rates are modest, APRA has discovered a worrying rise in the share of home loans approved with risky loan-to-property value ratios.

‘A stunning 33 per cent of new home loans are today being advanced with LVRs greater than 80 per cent. In some countries they don’t even allow banks to lend at these levels, period.’

Now, keep these points in mind when considering the Australian Prudential Regulation Authority (APRA)’s latest warning to the banks to maintain an adequate capital buffer and to not let lending standards slip.

But you can warn all you want. When interest rates reach historic lows, you begin to scrape the bottom of the barrel in terms of creditworthy borrowers. Because with each step down in rates, new marginal borrowers come into the market.

The problem is not banks lowering their lending standards (although that doesn’t help)…the problem is ultra-cheap money. It’s as simple as that. And ‘eventually’ those people now scrambling to get into the Australian property market will painfully understand this simple fact.

Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market.
To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.

You neglected to mention in this essay that the house in the Sydney suburb of Eastwood that sold for $2.385 million was bought by a visitor from China – and so it goes with an alarming number of sales here. Each driving up the price for locals. Indeed, it’s a top down approach which has a cascading effect across most suburbs, given that locals now have to move sideways to find a more affordable area. (do look at the faces in that crowd photo) Added to this, the Courier Mail reports a sale to a fellow who never left home… Read more »

“you have a property price bubble that you could argue is built on fundamentals.” “The fundamentals in this case being strong and rising national incomes, lack of new housing supply, cheap credit and the high cost of labour/supplies/regulations. But that’s the point…bubbles are always built on strong fundamentals. The problem is that this argument then becomes so blithely accepted that most don’t see when fundamentals stop being supportive of further growth.” Those factors cited as fundamentals are intermediate in duration. Unlike the topography,climate and resources which make the long term setting for this economy. As for the west generally our… Read more »

Garry, you are absolutely correct.
Aussie fundamentals such as employment, levels of interest rates and incomes are not the factors driving the prices up, it’s any number of foreign “investors” who don’t care how much they pay, as they have the deep pockets to get what they are after, and who cares the price!

I’ve heard many anecdotal stories about the number of properties being sold to overseas buyers, including one developer stating that 7 out of every 10 units he builds are sold to buyers from mainland China.

Politicians are dim and pumping up the property market in this way with the RBA’s help will lead to real problems down he track. No matter though the banks will be fine as the government will bail them out.

Yes Paul, the reasons for our sky high prices are out there in plain view. However, the ivory tower set who tell us what is wrong, never bother with visits to auctions – instead, they just fiddle with data sets and come up with all sorts of odd ball reasons to support their armchair views on high prices The real world works like this. 38 bidders signed up for a property that made $1m more than estimates. All of those bidders in Sydney were Asian. http://www.theage.com.au/business/property/chinese-buying-sydney-homes-at-record-rate-says-john-mcgrath-20130913-2tocn.html Indeed, one never has to leave the motherland to buy a property in distant… Read more »

funny that, most of the mansions chinese buys up is sitting empty and pretty already so you think they can head for exits or when price drop they will just add more to their portfolio. i know communis system is corrupted and deep down they want to live in democracy so all the corrupted officials (i say millions of them already buying up aussies land and houses and commercial business). when their country go to shits they just run over here.

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